FX Energy 10-K 2008
Documents found in this filing:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. As of June 29, 2007, the aggregate market value of the voting and nonvoting common equity held by nonaffiliates of the registrant was $321,319,000.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. As of March 3, 2008, FX Energy had outstanding 40,296,447 shares of its common stock, par value $0.001.
DOCUMENTS INCORPORATED BY REFERENCE. FX Energy’s definitive Proxy Statement in connection with the 2008 Annual Meeting of Stockholders is incorporated by reference in response to Part II, Item 5, and Part III of this Annual Report.
FX ENERGY, INC.
Form 10-K for the fiscal year ended December 31, 2007
TABLE OF CONTENTS
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This report contains statements about the future, sometimes referred to as “forward-looking” statements. Forward-looking statements are typically identified by the use of the words “believe,” “may,” “could,” “should,” “expect,” “anticipate,” “estimate,” “project,” “propose,” “plan,” “intend,” and similar words and expressions. Statements that describe our future strategic plans, goals, or objectives are also forward-looking statements. We intend that the forward-looking statements will be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Readers of this report are cautioned that any forward-looking statements, including those regarding us or our management’s current beliefs, expectations, anticipations, estimations, projections, strategies, proposals, plans, or intentions, are not guarantees of future performance or results of events and involve risks and uncertainties, such as:
The forward-looking information is based on present circumstances and on our predictions respecting events that have not occurred, that may not occur, or that may occur with different consequences from those now assumed or anticipated. Actual events or results may differ materially from those discussed in the forward-looking statements. The forward-looking statements included in this report are made only as of the date of this report.
ITEM 1. BUSINESS
We are an independent oil and gas exploration and production company headquartered in Salt Lake City, Utah. Our principal production, reserves, and exploration activities are in Poland, although we have a modest oil presence in the U.S. We hold 3.7 million gross acres (3.2 million net) in Poland. We believe Poland represents a unique international exploration opportunity. Relatively little gas has been discovered in Poland’s sector of the North European Permian Basin, compared to the discoveries in the United Kingdom, Dutch, and German sectors. For most of the 20th Century, the country was closed to exploration by foreign oil and gas companies. Consequently, we think the Polish Permian Basin is underexplored and underexploited.
Independent engineers estimated our total oil and gas reserves at 34.1 billion cubic feet of gas equivalents, or “Bcfe.” Our total oil and gas reserves increased approximately 50% from year end 2006 to 2007. Our production more than doubled from 2006 to 2007. In both cases, the increase was virtually all attributable to our exploration in Poland. See Item 7, Management’s Discussion and Analysis, for further information.
References to us in this report include FX Energy, Inc., our subsidiaries, and the entities or enterprises organized under Polish law in which we have an interest and through which we conduct our activities in that country. See “Oil and Gas Terms” at the end of Item 2, Properties, for definitions of certain industry terms.
We hold substantial acreage in productive fairways or geological trends, primarily in Poland, that we consider underexplored and underdeveloped, where we believe we have the opportunity to find significant gas and oil reserves while mitigating risk through the application of new exploration technology. Our strategy is to:
Relatively little gas has been discovered in Poland’s sector of the North European Permian Basin compared to the discoveries in the United Kingdom, Dutch, and German sectors. We believe Poland has substantial undiscovered hydrocarbon potential. We think the Polish portion of the Permian Basin is underexplored and underdeveloped today because the country was closed to competition and capital from foreign oil and gas companies for many decades. The continuous advances in exploration technology around the world were not immediately applied in Poland during the period it was behind the “Iron Curtain.”
Acting on this thesis, we have accumulated a large land position in known productive regions or geologic trends and in selected “rank wildcat” areas in Poland. We have assembled a sophisticated technical team with modern exploration tools and generated a number of attractive gas prospects. This has already begun to bear fruit with several new discoveries on which to build a production base to support our ongoing exploration program in Poland.
Some of our Polish operations are conducted in partnership with the Polish Oil and Gas Company, or POGC. POGC is a fully integrated oil and gas company, which is largely owned by the Treasury of the Republic of Poland. POGC is Poland’s principal domestic oil and gas exploration, production, transportation and distribution entity. Under our existing agreements, POGC has provided us with access to exploration opportunities, previously collected exploration data, and technical and operational support. We also use geophysical and drilling services provided by POGC and sell our gas production to POGC.
Current Activities and Assets in Poland
We focus our exploration efforts in Poland primarily on the Rotliegend sandstones of the Permian Basin. We were attracted to the Rotliegend sandstones in Poland by two observations:
We have identified a core area consisting of approximately 852,000 gross acres surrounding the Radlin field. This 390 billion cubic feet, or Bcf, Rotliegend gas field was discovered in the 1980s by our joint venture partner, POGC, which owns and produces gas from it. We have emphasized improved seismic data acquisition and processing in our exploration, using technology developed for Rotliegend exploration in the Southern North Sea. With this approach we have made commercially successful discoveries in four of the five wells we have drilled on Rotliegend structural targets using new two-dimensional, or 2-D, seismic data.
We have made commercial discoveries in the course of our Polish exploration which, at December 31, 2007, were estimated to total 31 Bcf of gas and 14,000 barrels, or Bbls, of light crude oil, net to our interest. Future net revenues, discounted to present value at 10% per annum, or PV-10 value, were estimated at approximately $103 million after taxes. These figures exclude all of our historical Polish production and cash flows through December 31, 2007.
Based on these discoveries and associated technical work, we have identified a subset of our acreage, the Sroda area, as having significant natural gas potential and low drilling risk. Within the Sroda area we have acquired three-dimensional, or 3-D, seismic data over several hundred square kilometers. Using this data, we have identified a number of possible structural traps. We believe the 3-D seismic data gives us better definition of the targets and might further reduce our drilling risk. We have scheduled two rigs for the Sroda area to carry out a multi-year exploration, appraisal, and development drilling program. Our operations in the Sroda area focus on the first element of our general strategy–increase production and reserves in our core area.
While maintaining our focus on the Rotliegend structural trap exploration model in our core area, we are also carrying out exploration work on other potential exploration models. These include non-Rotliegend prospects in our core area on various exploration opportunities on our 2.8 million net acres outside our core area. For example, we are currently drilling a well, the Grundy-1, to test a Zechstein carbonate prospect in our core concession. Outside our core concession we are acquiring seismic data on several possible leads in our Northwest concession block. We anticipate continuing exploration work on our non-core acreage and on the secondary exploration targets in our core area. However, the Rotliegend structural trap gas prospects in our core area will continue to receive the greatest portion of our efforts and capital resources.
Key Personnel for Poland
Our chief technical advisor is Richard Hardman, CBE. He also serves on our board of directors. Mr. Hardman has built a career in international exploration over the past 40 years in the upstream oil and gas industry as a geologist in Libya, Kuwait, Colombia, and Norway. In the United Kingdom, his career encompasses almost the whole of the exploration history of the North Sea – 1969 to the present. With Amerada Hess from 1983 to 2002 as Exploration Director and later Vice President of Exploration, he was responsible for key Amerada North Sea and international discoveries, including the Valhall, Scott, and South Arne fields. Mr. Hardman was made Commander of the British Empire in the New Year Honours, 1998, and has served as the Chairman of the Petroleum Society of Great Britain, President of the Geological Society, and President of the European Region of AAPG Europe. Mr. Hardman was appointed to our board of directors in October 2003 and is Chairman of our Technical and Advisory Panel.
Jerzy Maciolek is a director of the Company and, as Vice President of International Exploration, heads our exploration team. He joined the Company in 1995 specifically to lead it into Poland where he had identified the exploration opportunity that today is the Company’s core asset. Mr. Maciolek has over 25 years’ experience as a geophysicist with POGC, Gulf Oil Research, and as an independent consultant. He received an M.S. in exploration geophysics from the Mining and Metallurgical Academy in Krakow, Poland.
Our Country Manager in Poland is Zbigniew Tatys, the former General Director of POGC’s Upstream Exploration and Production Division. During his 20-year career with POGC, he rose through the ranks as a production engineer and was serving as Vice Chairman of POGC at the time of his retirement. Mr. Tatys has unique qualifications to lead us through our transition from a pure exploration company to an oil and natural gas producer in Poland.
Our U.S. Presence
Unlike our position in Poland, the U.S. operation does not have substantial exploration potential. It is fairly mature. It provides a modest amount of cash flow and is not capital intensive. It consists mostly of shallow, oil-producing wells in the Cut Bank oil field of Montana. As of December 31, 2007, our U.S. reserves were estimated at 482,000 barrels of crude oil with a PV-10 value of approximately $11 million.
Exploration, Development and Production Activities
Polish Exploration Rights
As of December 31, 2007, we held oil and gas exploration rights in Poland in the following gross acreage components:
As we explore and evaluate our acreage in Poland, we expect to increasingly focus our operational and financial efforts on higher potential areas. As we do so, we may add new concessions that we believe have high potential and relinquish acreage that we believe has lower potential. See “Wells and Acreage” below for further information.
Exploratory Activities in Poland
Our ongoing activities in Poland are conducted in six areas: Fences, Northwest, Kutno, Warsaw South, Block 255, and Block 287. Our exploration activities are currently focused primarily on the core Fences area, where the gas-bearing Rotliegend sandstone reservoir rock is a direct analog to the Southern North Sea gas basin offshore the United Kingdom. We are focused on this core area because substantial gas reserves have already been discovered and developed by POGC, we have made five commercial gas discoveries, together with POGC, containing proved gas reserves of approximately 72 Bcf gross (31 Bcf net to our interest), and we have concluded that there is likely to be substantial additional natural gas in the same geologic horizon.
The Fences concession area is 852,000 gross acres (3,450 sq. km.) in western Poland’s Permian Basin surrounding POGC’s Radlin gas field. The Radlin field and several other POGC gas fields located in the Fences area are “fenced off” or excluded from our exploration acreage. These fields, discovered by POGC between 1974 and 1982, produce from structural traps in the Rotliegend sandstone.
We hold a 49% interest in approximately 807,000 acres and a 24.5% interest in the remaining 45,000 acres in the Fences area.
The Rotliegend is the primary target horizon throughout most of the Fences concession area, at depths from approximately 2,500 to 4,000 meters. There are two types of Rotliegend traps in the region: structural traps and stratigraphic (“pinch-out”) traps. Both of these trap types are known to produce gas in the region. In addition, we have identified what appear to be carbonates in the Zechstein, a third type of trap that is known to produce both oil and gas in the region.
Fences Area: Structural Traps
Based on our drilling experience since 2000 in the Fences area, we have emphasized the use of acquisition, processing, and interpretation techniques that have been used successfully in the Rotliegend gas fields of the United Kingdom’s offshore Southern Gas Basin. With Rotliegend structures as our target, and utilizing improved seismic data processing and acquisition techniques, we have drilled six wells targeting Rotliegend structures. Five of these wells are commercial, with aggregate proved gas reserves of approximately 71 Bcf gross (31 Bcf net to our interest).
In January 2007, we completed the Winna Gora well as a commercial success (with production anticipated to begin at the end of 2009). At year-end, gross proved reserves for the well were estimated at approximately 7.5 Bcf of gas (3.7 Bcf net to our 49% interest). 3-D seismic data in the Winna Gora area will be available during 2008 and should assist us in determining whether to produce the existing vertical well or, alternatively, drill a horizontal well in this structure.
In May 2007, we completed the Roszkow-1 well as a commercial success (with initial production in late 2008 or early 2009). At December 31, 2007, gross proved reserves for the well were estimated at approximately 29.1 Bcf of gas (14.3 Bcf net to our 49% interest).
Three more wells targeting Rotliegend structural traps are scheduled to start drilling in 2008. Each well targets an as-yet undrilled structure in the area of the Sroda-4 and Sroda-5 wells. The structural targets are named: Kromolice-N, Kromolice-S, and Sroda City. These three wells will be located with the help of our recently completed 3-D seismic data.
As part of our focus on that part of the Fences area that is prone to Rotliegend structural traps, we have acquired several hundred square kilometers of 3-D seismic data and plan to acquire an additional 200 square kilometers of 3-D seismic data in 2008 in the area where the Sroda-4, Sroda-5, and Winna Gora wells are located and along the trend to the southeast. We also plan to acquire approximately 200 kilometers of 2-D seismic data over a lead, Taczanow, that lies on the trend southeast from the Zaniemysl and Roszkow wells, our two biggest discoveries to date.
Finally, in the northern-most part of our Fences concession and lying within the area covered by our recent 3-D seismic data, we have identified a very large upthrown block, or horst, of Rotliegend sandstone that encompasses approximately 50 square kilometers, or 12,000 acres, within our Fences concession, and continues into the area north of our concession. One well, the 1984 Plawce-1, was drilled on this Rotliegend block within what is now our Fences concession. Five other wells have been drilled in this block north of our concession boundary, all but one of them more than 20 years ago. All six of these wells had substantial gas columns, and all but the most recent well were plugged due to relatively tight reservoir rocks. The one new well, Trzek-1, located about 6 kilometers north of our concession, was drilled in 2007 and reportedly tested gas at rates between 2.5 and 7.5 million cubic feet of natural gas per day, or MMcfD, after hydraulic fracturing.
We are currently working with service companies that specialize in production from tight Rotliegend reservoirs in the southern United Kingdom gas basin and in Germany. Over the next few months we will prepare a plan to appraise and develop the gas resource in the Plawce area. We have scheduled additional field work in 2008 that will enhance the quality of our 3-D seismic and appraisal data in the Plawce area.
Fences Area: Stratigraphic Traps
In the southwestern portion of the Fences concession, outside the area prone to Rotliegend structures, there is potential for stratigraphic trapping, or pinch-outs, in the Rotliegend. Based on data from the Rusocin-1 and the Lugi-1 wells we drilled in 2005, and on the presence of wells that produce from stratigraphic traps further to the west from our concession, we plan to acquire 3-D data in 2009 that will help us determine the next steps in exploring the pinch-out area.
Fences Area: Carbonate (Reef) Traps
In the northeastern portion of the Fences concession, also outside the area prone to Rotliegend structures, we have identified what appear to be carbonate (reef) targets in the Zechstein (Ca2) horizon of the lower Permian, just above the Rotliegend. In February 2008 we began drilling the Grundy-1 well to test a possible Ca2 reef build-up identified on 2-D seismic. The Grundy-1 is located approximately 30 kilometers east of the Company’s Sroda area. The nearest significant Ca2 producing fields, the BMB and Miedzychód-Lubiatow-Grotów (“MLG”) oil and gas fields owned by POGC, are located approximately 60 to 80 kilometers northwest of the Grundy well location and reportedly contain approximately 125 million barrels of oil and 500 Bcf of gas.
Northwest Concession Area
In 2006, the Company acquired a 100% interest in a concession in west-central Poland covering 1.6 million acres. The concession is in Poland’s Permian Basin directly north of POGC’s BMB and MLG oil and gas fields. As in the Company’s Fences concession, the Northwest concession has three separate possible exploration models: Rotliegend sands trapping gas in structural closures; Rotliegend sands trapping gas in stratigraphic traps or pinchouts; and Zechstein Ca2 dolomitic sands, reefs, and talus trapping oil and gas.
During 2007 the Company’s technical team reviewed the existing sparse, 20 year old geological and geophysical data from the area. In an area of 1.6 million acres, there were only about 2,500 kilometers of 2-D seismic data and only three wells drilled to target depths. As a result of this review, we elected to relinquish approximately 500,000 acres from the northeast corner of this concession, retaining approximately 1.1 million acres. In January 2008, we initiated field work to acquire just over 200 kilometers of new 2-D seismic over several of the leads identified the previous year. We plan to seek industry participation while continuing to carry out early stage exploration work on our own.
Kutno Concession Area
In 2007, we acquired a 100% interest in a concession in central Poland covering 284,000 acres. The area encompasses a Rotliegend mega-structure (“Kutno”) with projected four-way dip closure. The interpreted gas column is 280 meters over an area of 143 square kilometers. With expected porosity of between 5% and 15%, the structure has a calculated potential gross volume of up to 19 trillion cubic feet. Depth of the structure is estimated at approximately 6,000 meters (19,200 feet). In view of the depth and cost, we are seeking industry participation to drill Kutno.
Warsaw South Concession Area
In 2007, we acquired a 100% interest in a concession in east central Poland covering approximately 935,000 acres. The Warsaw South concession has several possible exploration opportunities, including carboniferous sands with structural or truncation trapping and Zechstein reefs trapped by overlying evaporates and salt. During 2007, our technical group reviewed the geological and geophysical data from the area. The team identified a dozen carboniferous leads and two possible Zechstein reef targets. We plan to seek industry participation while continuing to carry out early stage exploration work on our own.
Block 255 Concession Area
The Block 255/Wilga concession area in east central Poland consists of an 82% working interest in approximately 250,000 gross acres. We have one producing well, Wilga-2, in Block 255, the result of an exploration project conducted several years ago by us and Apache Corporation. As of December 31, 2007, the Wilga well had remaining gross proved reserves of approximately 0.55 Bcf of gas and 16,900 barrels of light crude oil (0.45 Bcf and 14,000 barrels, net to our interest). Wilga-2 is currently producing approximately 1 MMcfD of high methane gas and 20 barrels of light crude oil per day from sands in the Carboniferous.
Block 287 Concession Area
The Block 287 concession area is 213,000 acres (863 sq. km.) located approximately 25 miles south of the Fences concession area. We own 100% of the exploration rights. Block 287 was part of a larger concession area which we relinquished in 2007 based on our technical evaluation and on a 2006 dry hole that we drilled.
Within Block 287 there are three Rotliegend gas wells known as the Grabowka wells. Originally drilled by POGC in 1983-85, these three wells tested gas but never produced commercially. In early 2007, we entered into a joint venture agreement with an unrelated party, PL Energia S.A., headquartered in Krzywoploty, Poland, under which all costs of re-entering and completing the three Grabowka wells and building production facilities will be paid by our joint venture partner in exchange for discounted pricing on gas. If our re-entry of these wells is commercial, the project is expected to come on-stream in the second half of 2008. We do not plan to conduct further technical work on Block 287.
Additional Concession Acreage
We have applied for additional concession blocks in Poland that have not yet been issued. We may apply for yet more concession blocks in Poland in 2008. We will allocate modest technical and financial resources to these areas during 2008, primarily in the form of data collection and seismic reprocessing, with a view to ascertaining relative hydrocarbon potential and exploration risk.
Activities and Assets in the United States
During 2007, we did not drill any wells. We may drill one or two exploratory wells in 2008 on land that is near our existing producing properties in Nevada.
During 2007, we did not drill any wells in Montana. We may drill one or two exploratory wells in 2008 using our own drilling rig.
Further information concerning our financial and geographic segments can be found in the footnotes to the consolidated financial statements.
We make available, free of charge, either on our website (www.fxenergy.com) or by contacting our main office in Salt Lake City, Utah at (801) 486-5555, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable as we file such material with, or furnish it to, the Securities and Exchange Commission.
ITEM 1A. RISK FACTORS
Our business is subject to a number of material risks, including, but not limited to, the following factors related directly and indirectly to our business activities in the United States and Poland.
Risks Relating to our Business
Our success depends largely on our discovery of economic quantities of oil or gas in Poland.
We currently have a limited amount of production in the United States and Poland. While during 2008 we anticipate that we will generate revenues in excess of our general and administrative costs, these revenues are not sufficient to cover all of our exploration and development costs, and we will continue to rely on existing working capital and possibly on funds from external sources to cover these costs. Our exploration programs in Poland are based on interpretations of geological and geophysical data. The factors listed below, most of which are outside our control, may prevent us from establishing additional commercial production or substantial reserves as a result of our exploration, appraisal, and development activities in Poland:
We have limited control over our exploration and development activities in Poland.
Our partner, POGC, holds the majority interest and is operator of our Fences project area and has a minority interest in our Wilga project area. As a paying partner, we rely to a significant extent on the financial capabilities of POGC. If POGC were to fail to perform its obligations under contracts with us, it would most likely have a material adverse effect on us. In particular, we have prepared our exploration budget through 2008 and beyond based on the participation of and funding to be provided by POGC. Although we have rights to participate in exploration and development activities on some POGC-controlled acreage, we have limited rights to initiate such activities. Further, we have no direct interest in some of the underlying agreements, licenses, and grants from the Polish agencies governing the exploration, exploitation, development, or production of acreage controlled by POGC. Thus, our program in Poland involving POGC-controlled acreage would be adversely affected if POGC should elect not to pursue activities on such acreage, if the relationship between us and POGC should deteriorate or terminate, or if POGC or the governmental agencies should fail to fulfill the requirements of or elect to terminate such agreements, licenses, or grants.
We cannot assure the exploration models we are using in Poland will lead to finding oil or gas in Poland.
We cannot assure the exploration models we and POGC have developed will provide a useful or effective guide for selecting exploration prospects and drilling targets. We will have to revise or replace these exploration models as a guide to further exploration if ongoing drilling results do not confirm their validity. These exploration models may be based on incomplete or unconfirmed data and theories that have not been fully tested. The seismic data, other technologies, and the study of producing fields in the area do not enable us to know conclusively prior to drilling that oil or gas will be present in commercial quantities. We cannot assure that the analogies that we draw from available data from other wells, more fully explored prospects, or producing fields will be applicable to our drilling prospects.
We cannot accurately predict the size of exploration targets or foresee all related risks.
Notwithstanding the accumulation and study of 2-D and 3-D seismic data, drilling logs, production information from established fields, and other data, we cannot predict accurately the oil or gas potential of individual prospects and drilling targets or the related risks. We sometimes predict the gross potential oil or gas in a particular area as part of our evaluation of the exploration potential and related risks. Our predictions are only rough, preliminary geological estimates of the forecasted volume and characteristics of possible reservoirs and the calculated potential oil or gas that could be contained if present. Such forecasts are not an assurance that our exploration will be successful or we will be able to establish reserves equal to such forecasts. In some cases, our estimates may be based on a review of data from other exploration or producing fields in the area that ultimately may be found not to be similar to our exploration prospects. We may require several test wells and long-term analysis of test data and history of production to determine the oil or gas potential of individual prospects.
We have had limited exploratory success in Poland.
We have participated in drilling 25 exploratory wells in Poland, including six commercial discoveries (the Wilga 2, Kleka 11, Zaniemysl-3, Sroda-4, Winna Gora-1, and Roszkow-1), and nineteen non-commercial wells. Of our six commercial successes in Poland, we were producing gas at our Wilga 2, Zaniemysl-3, and Kleka 11 wells as of December 31, 2007.
We may not achieve the results anticipated in placing our current or future discoveries into production.
We may encounter delays in commencing the production and the sale of gas in Poland, including our recent gas discoveries and other possible future discoveries. The possible delays may arise in obtaining rights-of-way to connect to the POGC pipeline system, obtaining construction permits, availability of materials and contractors, the signing of oil or gas purchase/sales contracts, and other factors. Such delays would correspondingly delay the commencement of cash flow and may require us to obtain additional short-term financing pending commencement of production. Further, we may design proposed surface and pipeline facilities based on possible estimated results of additional drilling. We cannot assure that additional drilling will establish additional reserves or production that will provide an economic return for planned expenditures for facilities. We may have to change our anticipated expenditures if costs of placing a particular discovery into production are higher, if the project is smaller, or if the commencement of production takes longer than expected.
Privatization/Nationalization of POGC could affect our relationship and future opportunities in Poland.
Our activities in Poland have benefited from our relationship with POGC, which has provided us with exploration acreage, seismic data, and production data under our agreements. The Polish government commenced the privatization of POGC by selling POGC’s refining assets and by successfully completing an initial public offering of approximately 15% of its stock. Complete privatization or a re-nationalization of POGC may result in new policies, strategies, or ownership that could adversely affect our existing relationship and agreements, as well as the availability of opportunities with POGC in the future.
We have a history of operating losses and may require additional capital in the future to fund our operations.
From our inception in January 1989 through December 31, 2007, we have incurred cumulative net losses of approximately $105 million. We expect that our exploration and production activities may continue to result in net losses through 2008 and possibly beyond, depending on whether our activities in Poland and the United States result in sufficient revenues to cover related operating expenses.
Until sufficient cash flow from operations can be obtained, we expect we will need additional capital to fully fund our ongoing planned exploration, appraisal, development, and property acquisition programs in Poland. We may seek required funds from the issuance of additional debt, equity or hybrid securities, project financing, strategic alliances, or other arrangements. Obtaining additional financing may dilute the interest of our existing stockholders or our interest in the specific project being financed. We cannot assure that additional funds could be obtained or, if obtained, would be on terms favorable to us. In addition to planned activities in Poland, we may require additional funds for general corporate purposes.
The loss of key personnel could have an adverse impact on our operations.
We rely on our officers and key employees and consultants and their expertise, particularly David N. Pierce, President and Chief Executive Officer; Thomas B. Lovejoy, Chairman of the Board and Executive Vice President; Andrew W. Pierce, Vice President-Operations; Jerzy B. Maciolek, Vice President-Exploration; Zbigniew Tatys, Poland Country Manager; and Richard Hardman, Director and Chairman of our technical committee. The loss of the services of any of these individuals may materially and adversely affect us. We have entered into employment agreements with our key executives. We do not maintain key-man insurance on any of our employees.
The price we receive for gas we sell will likely be lower than free market gas prices in western Europe.
Our limited number of wells and reserves means we cannot assure uninterruptible supply in sufficient quantities to meet the anticipated requirements of industrial users, so we currently are dependent on selling gas to POGC at prices generally lower than prevailing in western Europe. The market for the sale of gas in Poland is open to competition, but there are not yet many participants. Accordingly, we expect that the prices we receive for the gas we produce will be lower than would be the case in a fully competitive setting and may be lower than prevailing western European prices, at least until a fully competitive market develops in Poland or until we are able to assure potential purchasers other than POGC that we have sufficient wells and reserves to assure an uninterruptible supply in sufficient quantities. Further, there is no established market relationship between gas prices in short-term and long-term sales agreements. Notwithstanding the strong demand for gas in Poland, the availability of abundant quantities of gas from former members of the Soviet Union and the low cost of electricity from coal-fired generating facilities may also tend to depress gas prices in Poland.
Substantially all of the oil and gas currently produced in Poland is sold to a single customer or its affiliates.
We currently sell substantially all of the oil and gas produced in Poland to POGC or one of its affiliates. If POGC were to fail to perform its obligations under contracts with us, it would most likely have a material adverse effect on us. As discussed previously, the market for the sale of gas in Poland is open to competition, but there are not yet many participants. While our contracts provide us with the ability to market gas to other purchasers, including those outside of Poland, it may take a considerable amount of time to replace POGC as our primary customer.
Oil and gas price decreases and volatility could adversely affect our operations and our ability to obtain financing.
Oil and gas prices have been and are likely to continue to be volatile and subject to wide fluctuations in response to the following factors:
We have not entered into any agreements to protect us from price fluctuations and may or may not do so in the future.
Our industry is subject to numerous operating risks. Insurance may not be adequate to protect us against all these risks.
Our oil and gas drilling and production operations are subject to hazards incidental to the industry. These hazards include blowouts, cratering, explosions, uncontrollable flows of oil, gas or well fluids, fires, pollution, releases of toxic gas, and other environmental hazards and risks. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage, and suspension of operations. To lessen the effects of these hazards, we maintain insurance of various types to cover our domestic and international operations. We cannot assure that the insurance policies carried by us or by POGC, as operator of the Fences area, can continue to be obtained on reasonable terms. While we do carry limited third-party liability and all-risk insurance in Poland, we do not plan to purchase well control insurance on wells we drill in the Fences project area and may elect not to purchase such insurance on wells drilled in other areas in Poland as well. The current level of insurance does not cover all of the risks involved in oil and gas exploration, drilling and production. Where additional insurance coverage does exist, the amount of coverage may not be sufficient to pay the full amount of such liabilities. We may not be insured against all losses or liabilities that may arise from all hazards because such insurance is unavailable at economic rates, because of limitations on existing insurance coverage, or other factors. For example, we do not maintain insurance against risks related to violations of environmental laws. We would be adversely affected by a significant adverse event that is not fully covered by insurance. Further, we cannot assure that we will be able to maintain adequate insurance in the future at rates we consider reasonable.
Risks Relating to Conducting Business in Poland
Polish laws, regulations and policies may be changed in ways that could adversely impact our business.
Our oil and gas exploration, development, and production activities in Poland are and will continue to be subject to ongoing uncertainties and risks, including:
Poland has a developing regulatory regime, regulatory policies and interpretations.
Poland has a regulatory regime governing exploration and development, production, marketing, transportation, and storage of oil and gas. These provisions were promulgated during the past two decades and are relatively untested. Therefore, there is little or no administrative or enforcement history or established practice that can aid us in evaluating how the regulatory regime will affect our operations. It is possible those governmental policies will change or that new laws and regulations, administrative practices or policies, or interpretations of existing laws and regulations will materially and adversely affect our activities in Poland. For example, Poland’s laws, policies, and procedures were changed to conform to the requirements that had to be met before Poland was admitted as a full member of the European Union.
Our oil and gas operations are subject to changing environmental laws and regulations that could have a negative impact on our operations.
Operations on our project areas are subject to environmental laws and regulations in Poland that provide for restrictions and prohibitions on spills, releases, or emissions of various substances produced in association with oil and gas exploration and development. Additionally, if significant quantities of gas are produced with oil, regulations prohibiting the flaring of gas may inhibit oil production. In such circumstances, the absence of a gas gathering and delivering system may restrict production or may require significant expenditures to develop such a system prior to producing oil and gas. We are required to prepare and obtain approval of environmental impact assessments by governmental authorities in Poland prior to commencing oil or gas production, transportation, and processing functions. We are also subject to the requirements of Natura 2000, which is an ecological network in the territory of the European Union. In May 1992, governments of the European Union adopted legislation designed to protect the most seriously threatened habitats and species across Europe.
We and our partners cannot assure that we have complied with all applicable laws and regulations in drilling wells, acquiring seismic data, or completing other activities in Poland to date. The Polish government may adopt more restrictive regulations or administrative policies or practices. The cost of compliance with current regulations or any changes in environmental regulations could require significant expenditures. Further, breaches of such regulations may result in the imposition of fines and penalties, any of which may be material. These environmental costs could have an adverse effect on our financial condition, results of operations, or cash flows in the future.
Certain risks of loss arise from our need to conduct transactions in foreign currency.
The amounts in our agreements relating to our activities in Poland are sometimes expressed and payable in United States dollars and sometimes in Polish zlotys. Conversions between United States dollars and Polish zlotys are typically made on the date amounts are paid or received. In the future, our financial results and cash flows in Poland may be affected by fluctuations in exchange rates between the Polish zloty and the United States dollar. We have not hedged our foreign currency activities in the past and do not plan to do so. Currencies used by us may not be convertible at satisfactory rates. In addition, the official conversion rates between United States and Polish currencies may not accurately reflect the relative value of goods and services available or required in Poland. Further, inflation may lead to the devaluation of the Polish zloty.
The interests that we hold in concessions and usufructs owned in the name of POGC may be jeopardized or lost, without compensation to us, in the event of POGC’s bankruptcy, persistent breaches of laws such as environmental requirements, winding up, or other circumstances.
The Poland Ministry of the Environment, which administers the Geologic and Mining Law, has the authority to terminate concessions and usufructs in the name of POGC and in which we have a fractional undivided interest if POGC is declared bankrupt, persistently violates environmental regulations or other laws, is wound up, rescinds the concession, or otherwise breaches material usufruct or concession terms. There can be no assurance that POGC’s current 85% government ownership will continue or that the Poland government will in any circumstance intervene to prevent POGC’s insolvency or bankruptcy. We may not be able to implement effective measures to preserve and protect our property interests by curing any concession or usufruct default by POGC, assuring fair compensation in the event of any such loss, or implementing new legal strategies that would insulate our interests from loss due to POGC’s actions or condition.
Risks Related to an Investment in our Common Stock
Our stockholder rights plan and bylaws discourage unsolicited takeover proposals and could prevent our stockholders from realizing a premium on our common stock.
We have a stockholder rights plan that may have the effect of discouraging unsolicited takeover proposals. The rights issued under the stockholder rights plan would cause substantial dilution to a person or group that attempts to acquire us on terms not approved in advance by our board of directors. In addition, our articles of incorporation and bylaws contain provisions that may discourage unsolicited takeover proposals that our stockholders may consider to be in their best interests that include:
Together, these provisions and our stockholder rights plan may discourage transactions that otherwise could involve payment to our stockholders of a premium over prevailing market prices for our common shares.
Our common stock price has been and may continue to be extremely volatile.
Our common stock has traded as low as $4.41 and as high as $10.60 during intraday trading between January 1, 2007, and the date of this report. Some of the factors leading to this volatility include:
Exploration failures in Poland may adversely affect the trading prices for our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
The Republic of Poland
The Republic of Poland is located in central Europe, has a population of approximately 39 million people, and covers an area comparable in size to New Mexico. During 1989, Poland peacefully asserted its independence and became a parliamentary democracy. Since 1989, Poland has enacted comprehensive economic reform programs and stabilization measures that have enabled it to form a free-market economy and turn its economic ties from the east to the west, with most of its current international trade with the countries of the European Union and the United States. The economy has undergone extensive restructuring in the post-communist era. The Polish government credits foreign investment as a forceful growth factor in successfully creating a stable, free-market economy.
Since its transition to a market economy and a parliamentary democracy, Poland has experienced significant economic growth and political change. Poland has developed and is refining legal, tax, and regulatory systems characteristic of parliamentary democracies with interpretation and procedural safeguards. The Polish government has taken steps to harmonize Polish legislation with that of the European Union, which it joined in May of 2004.
Poland has created an attractive legal framework and fiscal regime for oil and gas exploration by actively encouraging investment by foreign companies to offset its lack of capital to further explore its oil and gas resources. In July 1995, Poland’s Council of Ministers approved a program to restructure and privatize the Polish petroleum sector. So far under this plan, a refinery located in Plock has been privatized as a publicly held company with its stock trading on the London and Warsaw stock exchanges. In September of 2005, POGC sold 15% of its stock in an initial public offering on the Warsaw Stock Exchange, raising a total of 2.7 billion Polish zlotys (approximately US$900 million).
Prior to becoming a parliamentary democracy during 1989, the exploration and development of Poland’s oil and gas resources were hindered by a combination of foreign influence, a centrally controlled economy, limited financial resources, and a lack of modern exploration technology. As a result of these and other factors, Poland is currently a net energy importer. Oil is imported primarily from countries of the former Soviet Union and the Middle East, and gas is imported primarily from Russia.
General Usufruct and Concession Terms
All of our rights in Poland have been awarded to us or to POGC pursuant to the Geological and Mining Law, which specifies the process for obtaining domestic exploration and exploitation rights. Under the Geological and Mining Law, the concession authority enters into mining usufruct (lease) agreements that grant the holder the exclusive right to explore for oil and gas in a designated area or to exploit the designated oil and/or gas field for a specified period under prescribed terms and conditions. The holder of the mining usufruct covering exploration must also acquire an exploration concession by applying to the concession authority and providing the opportunity for comment by local governmental authorities. The usufruct agreements include provisions that give the usufruct holder a claim for an extension of the usufruct (and the underlying concession), subject to having fulfilled all obligations under the usufruct and/or concession agreements.
Under current law, the concession authority requires that concessions and related usufructs be owned by a single entity, without recognizing any minority record ownership such as would reflect our interest in those areas in which we previously have been granted a minority ownership. As such, our ownership is subject to continued compliance with applicable law, the usufruct and concession terms, and solvency of POGC as the record owner.
The concession authority has granted us oil and gas exploration rights on the Block 287 and Wilga project areas, and has granted POGC oil and gas exploration rights on the Fences project areas. The agreements divide these areas into blocks, generally containing approximately 250,000 acres each. Concessions have been acquired for exploration in all areas that lie within existing usufructs. The exploration period begins after the date of the last concession signed under each respective usufruct. We believe all material concession terms have been satisfied to date.
If commercially viable oil or gas is discovered, the concession owner, during the first two years of production, then applies for an exploitation concession, as provided by the usufructs, generally with a term of 25 to 30 years or as long as commercial production continues. Upon the grant of the exploitation concession, the concession owner may become obligated to pay a fee, to be negotiated, but expected to be less than 1% of the market value of the estimated recoverable reserves in place. The concession owner would also be required to pay a royalty on any production, the amount of which will be set by the Council of Ministers, within a range established by legislation for the mineral being extracted. The royalty rate for high-methane gas is currently less than $0.07 per thousand cubic feet, or Mcf. This rate could be increased or decreased by the Council of Ministers to a rate between $0.02 and $0.10 per Mcf (the current statutory minimum and maximum royalty rates). Local governments will receive 60% of any royalties paid on production. The holder of the exploitation concession must also acquire rights to use the land from the surface owner and could be subject to significant delays in obtaining the consents of local authorities or satisfying other governmental requirements prior to obtaining an exploitation concession.
Existing Project Areas
Fences Project Area
The Fences project area consists of six oil and gas exploration concessions controlled by POGC, including two that were obtained as a result of a public tender in 2007. Three producing fields (Radlin, Kleka, and Kaleje) lie within the concession boundary, but are excluded from the Fences concessions. The original four concessions have expiration dates ranging from July 2008 to September 2012. Remaining work commitments in the aggregate for the four original concessions include acquiring: 200 kilometers of 2-D seismic data, 180 sq. km. of 3-D seismic data, and drilling two wells. POGC has filed an extension for the concession expiring in 2008 which we expect to be granted. The exploration period for the two new concessions will start after they are granted in 2008. The total work commitment for the two concessions is outlined in two phases: Phase I – three years: 260 kilometers of 2-D seismic data; Phase II – three years: drilling two wells.
Block 287 Project Area
The Block 287 project area consists of a single oil and gas exploration concession held by us. Several producing fields also lie within this concession’s boundaries, but are excluded from the Block 287 project area. The concession is for a period of six years ending in December 2009. Work commitments included acquiring 100 kilometers of new 2-D seismic data or drilling one well, which was satisfied by the drilling of the Drozdowice-1 well, and analysis and interpretation of existing well data. Beginning in the fourth year, there is a drilling requirement of a second well that will be satisfied by re-entering and producing the Grabowka gas field.
Wilga/Block 255 Project Area
The Wilga project area consists of a single oil and gas exploration concession held by us that expires in August 2009. The remaining period carries a work commitment of trial production of the Wilga gas-condensate field and 165 kilometers of 2-D seismic data.
Northwest Project Area
The Northwest project area consists of seven blocks originally awarded in October 2006, and four additional blocks that were awarded as part of a public tender in 2007. The total work commitment for the original seven blocks was outlined in three phases: Phase I - one year: reprocessing and reinterpretation of existing data; Phase II - two years: acquiring 960 kilometers of new 2-D seismic data; Phase III – three years: drilling seven wells. As a result of our analysis of existing data during Phase I, we dropped two of the original seven blocks in 2007. In January 2008, we began the acquisition of 220 kilometers of 2-D seismic data in three of the remaining five blocks. For the four new blocks, the exploration period will start after the concessions are granted in 2008. The total work commitment for the four new blocks is outlined in two phases: Phase I – three years: 280 kilometers of 2-D seismic data; Phase II – three years: drilling four wells.
Project areas added in 2007
Lublin/Warsaw South Project Area
This project area is adjacent to Block 255 and consists of five single exploration concessions granted in June, July, and September of 2007 for a period of six years. The total work commitment for the five concessions is outlined in three phases: Phase I – one year: reprocessing and reinterpretation of existing data; Phase II – two years: acquiring 630 kilometers of new 2-D seismic data; Phase III – three years: drilling five wells.
The Kutno concession consists of a single oil and gas exploration concession granted in March 2007 for a period of six years. The total work commitment is outlined in three phases: Phase I – one and one half years: reprocessing and reinterpretation of existing data; Phase II – two years: drilling one well; Phase III – two and one half years: drilling one well.
As of December 31, 2007, all required usufruct/concession payments had been made for each of the above project areas. Usufruct/concession payments on new concessions obtained beginning in 2006 are payable in annual installments over a three-year period.
Production, Transportation and Marketing
The following table sets forth our net daily gas and oil production, average sales price, and average production costs associated with our Polish production during 2007, 2006, and 2005:
Poland has a network of gas pipelines and crude oil pipelines traversing the country serving major metropolitan, commercial, industrial, and gas production areas, including significant portions of our acreage. Poland has a well-developed infrastructure of hard-surfaced roads and railways over which oil and/or light crude oil produced can be transported for sale. There are refineries in Gdansk and Plock in Poland and one in Germany near the western Polish border that we believe could process crude oil produced in Poland. Should we choose to export any oil or gas we produce, we will be required to obtain prior governmental approval.
We are currently selling all of our oil and gas production in Poland to POGC or one of its affiliates. Gas is sold pursuant to long-term sales contracts, typically for the life of each well, which obligate POGC to purchase all gas produced. Individual oil sales are negotiated with POGC-affiliated entities and are not subject to sales contracts.
United States Properties
In the United States, we currently produce oil in Montana and Nevada. All of our producing properties, except for the Rattlers Butte field (an exploratory discovery during 1997), were purchased during 1994. A summary of our average daily production, average working interest, and net revenue interest for our United States producing properties during 2007 follows:
In Montana, we operate the Cut Bank and Bears Den fields and have an interest in the Rattlers Butte field, which is operated by an industry partner. Production in the Cut Bank field, producing since the 1940s from an average depth of approximately 2,900 feet, is from a waterflood program with 120 producing oil wells, 29 active injection wells, and one active water supply well. The Bears Den field, under waterflood since 1990, is producing oil from five wells at a depth of approximately 2,430 feet, with one active water injection well. In the Rattlers Butte field, discovered during 1997, we own a 6.3% working interest in two oil wells producing at a depth of approximately 5,800 feet and one active water injection well.
In Nevada, we operate the Trap Springs and Munson Ranch fields and have an interest in the Bacon Flat field, which is operated by an industry partner. In the Trap Springs field, discovered in 1976, we produce oil from a depth of approximately 3,700 feet from one well. In the Munson Ranch field, discovered in 1988, we produce oil at an average depth of 3,800 feet from five wells. In the Bacon Flat field, discovered in 1981, we produce oil from one well at a depth of approximately 5,000 feet.
Production, Transportation and Marketing
The following table sets forth our average net daily oil production, average sales price and average production costs associated with our United States oil production during 2007, 2006, and 2005:
We sell oil at posted field prices to one of several purchasers in each of our production areas. We sell all of our Montana production, which represents over 94% of our total oil sales, to CENEX, a regional refiner and marketer. Posted prices are generally competitive among crude oil purchasers. Our crude oil sales contracts may be terminated by either party upon 30 days’ notice.
Oilfield Services – Drilling Rig and Well-Servicing Equipment
In Montana, we perform, through our drilling subsidiary, FX Drilling Company, Inc., a variety of third-party contract oilfield services, including drilling, workovers, location work, cementing, and acidizing. We currently have a drilling rig capable of drilling to a vertical depth of 6,000 feet, a workover rig, two service rigs, cementing equipment, acidizing equipment, and other associated oilfield servicing equipment.
Proved reserves are the estimated quantities of crude oil and natural gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reserves under existing economic and operating conditions. Our proved oil and gas reserve quantities and values are based on estimates prepared by independent reserve engineers in accordance with guidelines established by the Securities and Exchange Commission, or SEC. Operating costs, production taxes, and development costs were deducted in determining the quantity and value information. Such costs were estimated based on current costs and were not adjusted to anticipate increases due to inflation or other factors. No price escalations were assumed, and no amounts were deducted for general overhead, depreciation, depletion and amortization, and interest expense. The proved reserve quantity and value information is based on the weighted average price on December 31, 2007, of $93.68 per Bbl of oil and $5.61 per Mcf of gas in Poland and $81.07 per Bbl for oil in the United States. The determination of oil and gas reserves is based on estimates and is highly complex and interpretive, as there are numerous uncertainties inherent in estimating quantities and values of proved reserves, projecting future rates of production, and the timing and amount of development expenditures. The estimated present value, discounted at 10% per annum, of the future net cash flows, the Standardized Measure of Future Net Cash Flows (“SMOG”), or PV-10 Value, was determined in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 69, “Disclosure About Oil and Gas Activities,” and SEC guidelines. Our proved reserve estimates are subject to continuing revisions as additional information becomes available or assumptions change.
Estimates of our proved United States oil reserves were prepared by Larry Krause Consulting, an independent engineering firm in Billings, Montana. Estimates of our proved Polish gas reserves were prepared by RPS Energy, an independent engineering firm in the United Kingdom. No estimates of our proved reserves were filed with or included in any report to any other federal agency during 2007.
The following summary of proved reserve information as of December 31, 2007, represents discounted, after tax estimates net to us only, and should not be construed as exact:
The following table sets forth the exploratory wells that we drilled during the years ended December 31, 2007, 2006, and 2005:
Wells and Acreage
The following table sets forth our gross and net acres of developed and undeveloped oil and gas acreage as of December 31, 2007:
Our activities in Poland are subject to political, economic, and other uncertainties, including the adoption of new laws, regulations, or administrative policies that may adversely affect us or the terms of our exploration or production rights; political instability and changes in government or public or administrative policies; export and transportation tariffs and local and national taxes; foreign exchange and currency restrictions and fluctuations; repatriation limitations; inflation; environmental regulations; and other matters. These operations in Poland are subject to the Geological and Mining Law dated as of September 4, 1994 (as amended), and the Protection and Management of the Environment Act dated as of January 31, 1980 (as amended), which are the current primary statutes governing environmental protection. Agreements with the government of Poland respecting our areas create certain standards to be met regarding environmental protection. Participants in oil and gas exploration, development, and production activities generally are required to: (1) adhere to good international petroleum industry practices, including practices relating to the protection of the environment; and (2) prepare and submit geological work plans, with specific attention to environmental matters, to the appropriate agency of state geological administration for its approval prior to engaging in field operations such as seismic data acquisition, exploratory drilling, and field-wide development. Poland’s regulatory framework respecting environmental protection is not as fully developed and detailed as that which exists in the United States. We intend to conduct our operations in Poland in accordance with good international petroleum industry practices and, as they continue to develop, Polish requirements.
State and Local Regulation of Drilling and Production
Our exploration and production operations are subject to various types of regulation at the federal, state, and local levels. Such regulation includes requiring permits for the drilling of wells, maintaining bonding requirements in order to drill or operate wells and regulating the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, and the plugging and abandoning of wells. Our operations are also subject to various conservation laws and regulations. These include the regulation of the size of drilling and spacing units or proration units and the density of wells that may be drilled and the unitization or pooling of oil and gas properties. In this regard, some states allow the forced pooling or integration of tracts to facilitate exploration while other states rely on voluntary pooling of lands and leases. In addition, state conservation laws establish maximum rates of production from oil and gas wells, generally prohibit the venting or flaring of gas, and impose certain requirements regarding the ratability of production.
Our oil production is affected to some degree by state regulations. States in which we operate have statutory provisions regulating the production and sale of oil and gas, including provisions regarding deliverability. Such statutes and related regulations are generally intended to prevent waste of oil and gas and to protect correlative rights to produce oil and gas between owners of a common reservoir. Certain state regulatory authorities also regulate the amount of oil and gas produced by assigning allowable rates of production to each well or proration unit.
The federal government and various state and local governments have adopted laws and regulations regarding the control of contamination of the environment. These laws and regulations may require the acquisition of a permit by operators before drilling commences; restrict the types, quantities, and concentration of various substances that can be released into the environment in connection with drilling and production activities; limit or prohibit drilling activities on certain lands lying within wilderness, wetlands, and other protected areas; and impose substantial liabilities for pollution resulting from our operations. These laws and regulations may also increase the costs of drilling and operating wells. We may also be held liable for the costs of removal and damages arising out of a pollution incident to the extent set forth in the Federal Water Pollution Control Act, as amended by the Oil Pollution Act of 1990, or OPA ‘90. In addition, we may be subject to other civil claims arising out of any such incident. As with any owner of property, we are also subject to clean-up costs and liability for hazardous materials, asbestos, or any other toxic or hazardous substance that may exist on or under any of our properties. We believe that we are in compliance in all material respects with such laws, rules, and regulations and that continued compliance will not have a material adverse effect on our operations or financial condition. Furthermore, we do not believe that we are affected in a significantly different manner by these laws and regulations than our competitors in the oil and gas industry.
The Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, also known as the “Superfund” law, imposes liability, without regard to fault or the legality of the original conduct, on certain classes of persons that are considered to be responsible for the release of a “hazardous substance” into the environment. These persons include the owner or operator of the disposal site or sites where the release occurred and companies that disposed or arranged for the disposal of the hazardous substances. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources, and for the costs of certain health studies. Furthermore, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by hazardous substances or other pollutants released into the environment.
The Resource Conservation and Recovery Act, or RCRA, and regulations promulgated thereunder govern the generation, storage, transfer, and disposal of hazardous wastes. RCRA, however, excludes from the definition of hazardous wastes “drilling fluids, produced waters, and other wastes associated with the exploration, development, or production of crude oil, gas, or geothermal energy.” Because of this exclusion, many of our operations are exempt from RCRA regulation. Nevertheless, we must comply with RCRA regulations for any of our operations that do not fall within the RCRA exclusion.
The OPA ‘90 and related regulations impose a variety of regulations on responsible parties related to the prevention of oil spills and liability for damages resulting from such spills. OPA ‘90 establishes strict liability for owners of facilities that are the site of a release of oil into “waters of the United States.” While OPA ‘90 liability more typically applies to facilities near substantial bodies of water, at least one district court has held that OPA ‘90 liability can attach if the contamination could enter waters that may flow into navigable waters.
Stricter standards in environmental legislation may be imposed on the oil and gas industry in the future, such as proposals made in Congress and at the state level from time to time, that would reclassify certain oil and gas exploration and production wastes as “hazardous wastes” and make the reclassified wastes subject to more stringent and costly handling, disposal, and clean-up requirements. The impact of any such changes, however, would not likely be any more burdensome to us than to any other similarly situated company involved in oil and gas exploration and production.
Federal and Indian Leases
A substantial part of our producing properties in Montana consists of oil and gas leases issued by the Bureau of Land Management or by the Blackfeet Tribe under the supervision of the Bureau of Indian Affairs. Our activities on these properties must comply with rules and orders that regulate aspects of the oil and gas industry, including drilling and operating on leased land and the calculation and payment of royalties to the federal government or the governing Indian nation. Our operations on Indian lands must also comply with applicable requirements of the governing body of the tribe involved including, in some instances, the employment of tribal members. We believe we are currently in full compliance with all material provisions of such regulations.
Safety and Health Regulations
We must also conduct our operations in accordance with various laws and regulations concerning occupational safety and health. Currently, we do not foresee expending material amounts to comply with these occupational safety and health laws and regulations. However, since such laws and regulations are frequently changed, we are unable to predict the future effect of these laws and regulations.
Title to Properties
We rely on sovereign ownership of exploration rights and mineral interests by the Polish government in connection with our activities in Poland and have not conducted and do not plan to conduct any independent title examination. We regularly consult with our Polish legal counsel when doing business in Poland.
Nearly all of our United States working interests are held under leases from third parties. We typically obtain a title opinion concerning such properties prior to the commencement of drilling operations. We have obtained such title opinions or other third-party review on all of our producing properties, and we believe that we have satisfactory title to all such properties sufficient to meet standards generally accepted in the oil and gas industry. Our United States properties are subject to typical burdens, including customary royalty interests and liens for current taxes, but we have concluded that such burdens do not materially interfere with the use of such properties. Further, we believe the economic effects of such burdens have been appropriately reflected in our acquisition cost of such properties and reserve estimates. Title investigation before the acquisition of undeveloped properties is less thorough than that conducted prior to drilling, as is standard practice in the industry.
Employees and Consultants
As of December 31, 2007, we had 40 employees, consisting of nine in Salt Lake City, Utah; 20 in Oilmont, Montana; one in Greenwich, Connecticut; three in Houston, Texas; and seven in Poland. Our employees are not represented by a collective bargaining organization. We consider our relationship with our employees to be satisfactory. We also regularly engage technical consultants to provide specific geological, geophysical, and other professional services. Our executive officers and other management employees regularly travel to Poland to supervise activities conducted by our staff and others under contract on our behalf.
Offices and Facilities
Our corporate offices, located at 3006 Highland Drive, Salt Lake City, Utah, contain approximately 3,500 square feet and are rented at $3,400 per month under a month-to-month agreement. In Montana, we own a 16,160 square foot building located at the corner of Central and Main in Oilmont. We also have an office in Warsaw, Poland, located at Ul. Chalubinskiego 8, which we rent for approximately $4,300 per month.
Oil and Gas Terms
“Appraisal well” means a well drilled following a successful exploratory well used to determine the physical extent, reserves and likely production rate of a field.
“Bbl” means oilfield barrel.
“Bcf” means billion cubic feet of natural gas.
“Bcfe” means billion cubic feet of natural gas equivalent using a ratio of one barrel of oil to 6,000 cubic feet of natural gas.
“Development well” means a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.
“Exploratory well” means a well drilled to find and produce oil or gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir.
“Field” means an area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic conditions.
“Gross” acres and “gross” wells mean the total number of acres or wells, as the case may be, in which an interest is owned, either directly or through a subsidiary or other Polish enterprise in which we have an interest.
“Horizon” means an underground geological formation that is the portion of the larger formation that has sufficient porosity and permeability to constitute a reservoir.
“LCO” means light crude oil.
“MBbls” means thousand oilfield barrels.
“Mcf” means thousand cubic feet of natural gas.
“Mcfe” means thousand cubic feet of natural gas equivalent using a ratio of one barrel of oil to 6,000 cubic feet of natural gas.
“MMcf” means million cubic feet of natural gas.
“MMcfD” means million cubic feet of natural gas per day.
“Net” means, when referring to wells or acres, the fractional ownership working interests held by us, either directly or through a subsidiary or other Polish enterprise in which we have an interest, multiplied by the gross wells or acres.
“Proved reserves” means the estimated quantities of crude oil, gas and gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years fromknown reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. “Proved reserves” may be developed or undeveloped.
“PV-10 Value” means the estimated future net revenue to be generated from the production of proved reserves discounted to present value using an annual discount rate of 10.0%, the Standardized Measure of Future Net Cash Flows (“SMOG”). These amounts are calculated net of estimated production costs, future development costs and future income taxes, using prices and costs in effect as of a certain date, without escalation and without giving effect to non property-related expenses, such general and administrative costs, debt service, and depreciation, depletion and amortization.
“Reservoir” means a porous and permeable underground formation containing a natural accumulation of producible oil and/or gas that is confined by impermeable rock or water barriers and that is distinct and separate from other reservoirs.
“Tcf” means trillion cubic feet of natural gas.
“Usufruct” means the Polish equivalent of a U.S. oil and gas lease.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings, and no material legal proceedings have been threatened by us or, to the best of our knowledge, against us, except as follows:
In November and December 2007, three actions were filed in the United States District Court for the District of Utah against us and officers or directors David N. Pierce, Clay Newton, Thomas B. Lovejoy, Andrew W. Pierce, and Richard Hardman, by three separate plaintiffs, each seeking class certification to proceed on behalf of all others similarly situated and alleging violations by the defendants of the antifraud provisions of the federal securities laws set forth in Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder relating to our public statements about our oil and gas activities and prospects in Poland between March 2004 and January 2006. The complaints seek damages to be determined at trial, interest, and costs, together with such other relief as the court may deem appropriate. The three actions have now been consolidated into a single matter, and the lead plaintiffs and counsel have been specified. The consolidated actions have not been certified to proceed as a class action. No responsive pleading from the defendants will be due until an amended complaint is filed. We propose to defend vigorously this action on behalf of all defendants.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2007.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock and Dividend Policy
The following table sets forth, for the periods indicated, the high and low closing prices for our common stock as quoted under the symbol “FXEN” on the NASDAQ Global Market, or its predecessor, Nasdaq National Market:
We have never paid cash dividends on our common stock and do not anticipate that we will pay dividends in the foreseeable future. We intend to reinvest any future earnings to further expand our business. We estimate that, as of March 2, 2008, we had approximately 10,000 stockholders.
Equity Compensation Plans
The information from the definitive proxy statement for the 2008 annual meeting of stockholders under the caption “Equity Compensation Plans” is incorporated herein by reference.
Recent Sales of Unregistered Securities
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for the five years ended December 31, 2007, are derived from our audited consolidated financial statements and notes thereto, certain of which are included in this report. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the notes thereto included elsewhere in this report:
– Continued –
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our historical financial condition and results of operations should be read in conjunction with Item 6, Selected Consolidated Financial Data, our consolidated financial statements and related notes contained in this report.
As a result of the very different characteristics of our two major operating areas (Poland and U.S.), our financial results show a distinct dichotomy. Our Polish operations are early in their initial development and growth phase, while our U.S. operations are relatively mature. Thus, in late 2006, our results began to show substantial changes and improvement. See “Results of Operations by Business Segment” below.
Through 2006, most of our oil and gas production, revenues, and lease operating expenses were attributable to our U.S. operations. Our oilfield service revenues and costs have been and will continue to be exclusively from the U.S. Our U.S. operations have historically been the source of essentially all of our operating cash flow. These operations are relatively stable, with only modest growth or decline on an annual basis.
Our 2007 operations reflect a major shift for us, as our exploration efforts in Poland led to our first meaningful production there commencing in late 2006. At that time, we began producing and selling gas from two more of our six commercial discoveries, the Wilga and Zaniemysl wells. Revenues from our Polish properties became the primary component of our revenue in 2007, and will increase further when three more of our commercial wells begin production in 2009 and 2010.
Most of our exploration costs during the past several years have been attributable to our efforts in Poland. We expect our Polish operations will continue to represent the bulk of our exploration costs, reflecting the nature of our exploration efforts there.
Following is a brief discussion concerning certain significant operational and capital events that occurred during 2007 and the first quarter of 2008.
Recent Operational Events
As a result of our ongoing drilling and production successes in Poland, 2007 was a record year for the Company in terms of revenues, oil and gas production, and year-end proved reserve volumes and values.